Monday, July 23, 2007

Signs of the Economic Apocalypse, 7-23-07

From Signs of the Times:

Gold closed at 684.70 dollars an ounce Friday, up 2.6% from $667.30 at the close of the previous Friday. The dollar closed at 0.7232 euros Friday, down 0.3% from 0.7255 at the previous week’s close. That the euro, then, closed at 1.3827 dollars compared to 1.3783 the Friday before. Gold in euros would be 495.19 euros an ounce, up 2.3% from 484.15 for the week. Oil closed at 75.79 dollars a barrel Friday, up 2.5% from $73.93 at the close of the week before. Oil in euros would be 54.81 euros an ounce, up 2.2% from 53.64 for the week. The gold/oil ratio closed at 9.03, unchanged from the week before. In U.S. stocks, the Dow closed at 13,851.08, down 0.4% from 13,907.25 at the close of the week before. The NASDAQ closed at 2,687.60 Friday, down 0.7% from 2,707.00 for the week. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.95%, down 15 basis points from 5.10 at the end of the previous week.

The dollar continued its plunge last week, falling 2.6% against gold, 0.3% against the euro and 2.5% against oil. Interestingly, long term dollar interest rates dropped 23 basis points over the last two weeks. The dollar seems to be a victim of a risky but deliberate policy by Fed chair Ben Bernanke to lower it:
Traders ask how low can the dollar go

Michael Mackenzie

July 22 2007

How long before the dollar hits $1.40 to the euro? That is the question many analysts are asking after a week when the US currency struck a new low of $1.3843 to the euro and fresh multiyear lows against a range of currencies, including sterling.

The US currency has fallen 4.5 per cent against the euro this year and 4 per cent against sterling, hitting a new 26-year nadir against the pound last week. The trade-weighted dollar index dropped to its lowest since 1992.

The dollar exchange rate is important because the US relies on hefty foreign purchases of securities and other assets to fund its current account deficit.

“At some point, the fall in the dollar will translate into foreign investors no longer buying US assets and selling their existing holdings,” said William Strazzullo, chief market strategist at BellCurve Trading.

“We expect euro/dollar to appreciate to $1.42 by the end of the quarter and sterling/dollar to to move to $2.10 as investors reduce their dollar-denominated exposure,” said Hans Redeker at BNP Paribas.

The beleaguered US currency was hardly helped by Fed chairman Ben Bernanke last week. Questioned by Congress, he pointedly declined any chance to say the dollar was undervalued.

“[Predecessor Alan] Greenspan would at least say something about the dollar, showing he cared, which is something that many thought was absent in Bernanke’s empty response on the dollar,” said Tony Crescenzi, strategist at Miller Tabak & Co.

Mr Bernanke may have been guided by the idea “talking about the dollar is one of those things best left untouched”, said Alan Ruskin, chief international strategist at RBS Greenwich Capital.

Official silence on the dollar’s woes also extends to Hank Paulson, US Treasury secretary. “You get the sense the administration wants a weaker dollar,” said Mr Strazzullo.

A US economy growing more slowly than global rivals and interest rates rising outside the US while domestic rates remain on hold explain much of the dollar’s weakness. The greenback is also suffering anxiety over US credit and mortgage markets.

With Michael Moore’s new film, Sicko, doing well at the box office in the United States, the U.S. public is getting a rare look at the advantages of European-style social democracy. Normally, they are only given bad news about other systems, but it is getting harder to hide the advantages of other countries’ social welfare policies. Here are two columns, the first by an obscure blogger (Badtux, the Snarky Penguin) another by a well known novelist and columnist, singing the praises of Scandinavian society:
Those poor Scandinavians...

I mean, they got that socialist medicine thingy going. They got those high taxes and stuff. They probably live in grey dreary cities, eating mush for supper, in impoverished dreary nations where everybody is poor and stuff, right?

Errr... not so much. Turns out that one in 85 Norwegians is a millionaire, as vs. 1 in 125 Americans. *AND* they get free health care. *AND* they get free university tuition. *AND* they have the world's best infant mortality figures. *AND* they have the world's longest lifespan. And their cities are beautiful. And income inequality is relatively low -- with living wage laws and high taxes, the middle class actually control more of the national income than the upper class, and unlike here in the United States, the middle class is seeing their standard of living improve, not decline. Wow, imagine that, what a remarkable thing that must be!

Crap, if that's what socialized medicine and high taxes do for a people, gimme some of dat!

Badtux the neo-Scandinavian Penguin
Here is Garrison Keillor:
Isn't it good, Norwegian oil

The folks who emigrated to the primitive Midwest from the little villages in Norway missed out on the country's great oil and gas bonanza.

By Garrison Keillor

July 18, 2007

This week I am traveling around the part of Norway you see in the travel brochures -- the fjords with picturesque villages on the shores, forested mountains with thousand-foot waterfalls coursing down the precipices, old wooden fishing boats anchored in the harbor, old churches. An American walks around and wonders, "Where are the auto salvage yards, the strip malls, the golden arches?" This is a country that believes in zoning and government regulation. Government trolls will not allow you to open up a Mr. Donut drive-in unless you disguise it as a shop.

This morning we visited a village whose name cannot be printed in an American newspaper because it contains a vowel we don't have -- the A with a tiny O over it -- a village of 300 that is visited by 250,000 cruise ship visitors a year. It's as if Minneapolis were to be visited every summer by the Chinese People. The proportion of 250,000 visitors to 300 residents means that all the villagers are in retail. They sell a lot of Norwegian sweaters. Floridians and Californians come on a cruise ship in July and expect to find summer and they find chilly days and a light drizzle and they get cold and need to wrap themselves in wool. The sale of sweaters enables the villagers to lock up after Christmas and spend January, February and March in Florida or California.

Ancient burial mounds here tell us something about the Vikings. For one thing, when a chieftain died, his people killed a slave woman to go along with him to the afterlife. They asked for volunteers and since the lives of slave women were hard, there were some who were willing to take their chances on entering paradise. We also learn that the Vikings were expert woodworkers, which was how they were able to discover America 400 years before Columbus. They knew how to join wood and make ships that would stand up to the North Atlantic. And when St. Olaf converted them to Christianity in the 11th century and they swung away from Odin and Freja and Thor and the skaldic sagas and took up the epistles of St. Paul, they gave up domination by force and learned the art of passive aggression.

In Moorhead, Minn., you'll find a fine replica of an 11th century Norwegian stave church, which looks a little odd there with few trees and no mountains. And that's how the Norwegian emigrants felt who wound up on the prairie. The sky was too big and they had to learn to walk on level ground. But life was hard in Norway. The Black Plague had killed off half the country in the 14th century and made it defenseless, and so Norway fell under the woolen fist of Danish oppression until Denmark chose the wrong side in the Napoleonic wars and was forced by Britain to give Norway to Sweden, and between the Danes and the Swedes they managed to give Norway a national inferiority complex that lasted even beyond national independence in 1905. In these little villages along the fjords, people wearied of vertical agriculture and began emigrating to the Midwest back when it was a primitive frontier.

A Norwegian hates to admit a mistake, however, so the emigrants wrote glowing letters back to Norway, which lured even more Norwegians to the Midwest, so they missed out on the great Norwegian oil and gas bonanza of the past 50 years. Our oil profits go to robber barons who give it to their wastrel children to subsidize lives of insane narcissism, but Norwegian oil profits go mostly to the Norwegian people and subsidize the little villages and the roads and rails needed to connect them -- Norwegians are in favor of provincialism -- and also go to the largest pension fund in Europe, $300 billion, which is forecast to more than double in the next 10 years.

American Norwegians live in little prairie towns where health care is the main industry because everybody's old and their main asset is their home, which isn't worth what it was because the town is shrinking because old people have a tendency to die. Their ancestors took a wrong turn. They had no idea America would fall into the hands of a failed oilman who would waste the country's pension money on a war for oil while Norway, the world's most peaceful country, enjoys a very sensible prosperity. They've voted twice to stay out of the European Union. Why mess with success?
It’s getting harder for the powers that be in the United States to convince the public that the U.S. is the “Greatest Country in the World.” But their task is not impossible thanks to the power of dissociation. Americans will complain about one thing or another, they will see the faults very clearly, but then will dissociate and say, “it’s still the Greatest Country in the World.” It’s the whole “self esteem” phenomenon on a national level. Here is the Badtux blogger again:
Self Esteem

July 18, 2007

The notion of "self esteem" is the notion that somehow feeling good about yourself means a damned thing other than that you feel good about yourself.

Back when I was teaching in an inner city school in Houston, the central office sent down one of those damned "self esteem" curriculums. I looked around at my classroom, and threw it in the trash. Because if you wanted those kids to feel good about themselves, what was needed wasn't "self esteem". What was needed was clean, safe housing with enough beds for all the kids so kids didn't have to sleep three to a bed. What was needed was a living wage so that these kids' parents didn't have to work 16 hours a day just to keep a vermin-ridden roof over their head and could, like, actually raise their kids rather than being a distant presence only seen during rare weekend periods when one parent wasn't working. What was needed was competent teachers and adequate schooling rather than newbie teachers right out of teacher colleges who didn't have the foggiest notion how to talk to black kids in the ghetto much less teach them. What they needed was hope for the future, hope that they certainly weren't gonna get from a Texas legislature busily cutting children's health care and raising college tuitions, hope they certainly weren't gonna get from a Republican administration in Washington D.C. that was busily gutting the Pell Grant program for sending poor kids to college. What they saw was a dismal dreary present today and the same dismal, dreary future that their parents had, regardless of what they tried to do with their lives, and justifiably they weren't too happy about that.

But noooo, these kids problems weren't all that. These kids' problems were... low self esteem. So the message we teachers were supposed to impart was: Don't worry, be happy.

Now, the whole notion of "self esteem" is a strange one. I'd say a queer one, but then the gay rights activists would get outraged and stuff, so anyhow. Science is about things that are measurable. But who has ever seen a "self esteem"? So the floggers of the whole "don't worry, be happy" thingy created test instruments full of questions like, "I feel good about myself", and "I feel capable", and then defined "self esteem" as scoring high on that test. The problem then becomes the same damned thing that my professor in Social Sciences Research 501 taught me in grad school: Correlation is not causation.

For example, there is a correlation between umbrellas and rain. If you see a lot of umbrellas, it is likely to either be currently raining, or to start raining shortly. But this doesn't mean that umbrellas cause rain, any more than summer causes drownings. The actual cause of rain is something else entirely.

Similarly, the self esteem gurus with their tests discovered that well-off suburban kids who answered "1" (Agree Strongly)_ on "I feel good about myself" scored higher on academic benchmarks than my inner city kids who answered "5" (Disagree strongly) on that question. Duh. Why the f*** should my inner city kids have felt good about themselves? They were stuck in a horrible mess not of their own making, and every avenue for getting out of that shithole was being systematically taken away from them by Republican a******* whose attitude was "I got mine, and f*** everybody else", why should they have felt good about themselves? But the self esteem gurus then used this test to say, "high self esteem causes better school performance!"

Anyhow, that was the status quo for many years after I left teaching. Teachers were supposed to "foster self esteem" in their students. So finally -- finally --Baumeister et. al. did the research. They actually performed an experiment, as vs. a correlational study. The difference is that an experiment changes something. In this experiment, they taught kids to feel good about themselves (i.e. have high self-esteem). If you teach kids to feel good about themselves ("have high esteem"), do they actually perform better in school? Well, the answer, of course, is NO. In fact, for some kids it actually hurt their performance. After all, if you're already a perfect and wonderful person, what do you need all this schoolwork junk for?

So in the end, science backs up my gut feel from over a decade ago and shows that "self esteem" turns out to be meaningless. Folks feel good about themselves and their lives if they are in a good situation accomplishing things of worth, and feel bad about themselves and their lives if they're in a bad situation accomplishing nothing of worth. Kids who make good grades feel good about themselves because they make good grades, not the other way around. In other words, "self esteem" is effect, not cause. Other than in the special case of "learned helplessness", the whole concept of "self esteem" turns out to have no practical application.

On the other hand, for our rulers, the message "don't worry, be happy!" does make some sense, I suppose. Contented sheep, after all, are easier to fleece. But whether we're talking about low-achieving kids in school or fat people or whatever, "pumping up their self esteem" isn't the path to take in order to get better performance out of them. Rather, taking direct action to provide them better education, better nutritional and exercise choices, etc. while providing incentives to actually engage in those better choices is what needs to be done.

But that's practical advice. And everybody knows that what counts is how happy you are, not whether you are in fact smart or healthy or whatever. Alrighty, then!

Unfortunately, the shocks to come will most likely shatter all the buffers and dissociative states. Notice how in the following article from the Los Angeles Times about the valuation of mortgage backed securities, how the whole concept of “esteem” can be extended into the financial arena. Over-amped “esteem” can prop up markets… until they don’t anymore:

Wall Street can't cage its mortgage monster

Tom Petruno

July 22, 2007

When the rocket scientists on Wall Street outsmart even themselves, very bad things can happen.

The 1987 stock market crash was fueled by an institutional investment strategy that its creators ironically had termed "portfolio insurance."

The collapse of the giant hedge fund Long-Term Capital Management in 1998 was triggered by a sequence of market events that the fund's engineers believed couldn't occur in literally billions of years.

Today's version of Frankenstein turning on its creator is the mortgage loan mess. Wall Street in recent years has taken a simple concept — bundling mortgages and selling them to investors as interest-paying bonds — and concocted an alphabet soup of securities so incredibly complex they defy understanding by all but a handful of PhDs.

That complexity now is coming back to haunt the buyers of those securities, who for the most part are hedge funds and other big investors, not individuals. If you aren't sure what it is you own, you can't be confident about the thing's value. And in financial markets, if confidence dies, little else matters.

For months, Wall Street's standard line about the massive volume of mortgages made to high-risk borrowers since 2003 was that rising delinquencies on those so-called sub-prime loans were a manageable problem.

What's more, the line went, the trouble would be "contained" — meaning, it would be limited to the highest-risk loans and wouldn't spread up to better-quality mortgages or to better-quality mortgage-backed bonds.

Those assertions were all but blown away last week, after brokerage Bear Stearns Cos. on Tuesday disclosed that investors in two of its hedge funds that owned mortgage-backed securities had lost virtually all of their money.

It wasn't that the bonds became completely worthless overnight. Rather, the funds were victims of their heavy use of borrowed money to boost their bond bets. The use of debt, or leverage, magnifies an investor's gains when a portfolio is rising in value but also magnifies losses when the portfolio declines.

Still, leverage alone wasn't the problem. In its letter to clients, Bear Stearns reminded the rest of Wall Street what was happening with investors' perceptions of mortgage-backed bonds, even those purported to be of high quality.

Its funds were obliterated, the brokerage said, in part because of "the unprecedented declines in valuations of a number of highly rated — AA and AAA — securities."

For a AAA-rated bond, a serious decline is a drop in the market price from $1,000 to $950 in a matter of days. It may not look like much, but for a security that had the highest possible credit rating, that's a disaster.

Investors are losing faith in mortgage bonds up and down the quality chain because the major credit-rating firms — Standard & Poor's, Moody's Investors Service and Fitch Ratings — this month have begun to warn that loan delinquencies may be worse than what the firms had anticipated.

As they have cut their ratings, or put securities on "watch" for possible downgrades, the rating firms have helped unleash a torrent of fear.

Now, some owners of the riskiest mortgage bonds might like to sell, but the reality is that very few securities actually are changing hands.

Why is that? Because buyers are balking. After the biggest boom the housing industry has ever experienced, the bust could be unprecedented as well. So gauging how much of a loss a mortgage bond ultimately will experience — in other words, how many loans backing the security will go bad — is a difficult exercise for a potential buyer.

This is the peculiar problem of mortgage-backed securities. It isn't enough to know how many struggling homeowners will be forced into foreclosure. A bond investor also has to figure whether the foreclosed homes can be sold at prices that will cover the mortgages. And the investor has to guess how long the workout process could take.

Certainly, most Americans will make their mortgage payments, as they always have. But the $1.5 trillion in sub-prime mortgage bonds sold from 2003 through 2006 tells you that a huge number of high-risk borrowers were financed in that period. Some of those loans already have failed; more assuredly will fail.

What's more, in the sub-prime loan market it's now clear that fraud played a big role in the ease with which loans were granted as the housing boom peaked in 2006.

So what are investors supposed to believe about the underlying paperwork that describes a mortgage and the home that secures it?

"You cannot model [a bond for] the effects of fraud," said Andrew Lahde, head of Santa Monica-based Lahde Capital Management, which has been betting this year that mortgage bonds would plummet. "Fraud by definition is deception."

The difficulty in evaluating mortgage-backed securities has left potential sellers and buyers far apart. As many traders have described the situation in the last few weeks, a seller puts a bond up for sale hoping to get 80 cents on the dollar, only to find that potential buyers are offering no more than, say, 40 cents.

In this environment, "no one believes that AAA is AAA," which just echoes down the rating scale, said Janet Tavakoli, head of Tavakoli Structured Finance Inc. in Chicago and an expert on mortgage securities.

The seller then pulls the bond off the market. He hasn't realized a loss, but his anxiety level only rises because he's still stuck with the security in a worsening market.

As confusing as things are for mortgage bonds, it's worse for Wall Street engineers' crowning achievement in fee-generating securitization: collateralized debt obligations, or CDOs.

A CDO is, in effect, a bond backed by other bonds. And in a wondrous bit of alchemy, a CDO creator can take a pool of bonds backed by mostly sub-prime mortgages and turn it into securities that have AAA credit ratings.

It's all in the slicing and dicing of the underlying portfolio. In theory, the holder of a AAA-rated CDO slice owns a security that has almost no chance of losing principal.

But what, exactly, is backing that CDO slice? That's the question that many yield-hungry hedge funds and other big investors failed to ask in the boom years, said Christopher Whalen, an analyst at research firm Institutional Risk Analytics, which provides risk analysis to financial firms.

Now, "as mortgage default rates go up, investors are going to find out that what they own is not what they think it is," he said.

That is likely to be the unfolding story of the rest of this year and the first half of 2008.

The fire sale in mortgage securities has yet to begin. But it's coming. The implications for the rest of financial markets aren't clear, but when confidence is shaken in one market there usually is collateral damage.

Once again, Wall Street's rocket scientists have created a monster they can no longer control.


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